Is Bank Of America Stock Undervalued?

After falling nearly 25% year-to-date, an argument can be made that Bank of America (NYSE:BAC) is currently undervalued. The Financial Sector SPDR (NYSE:XLF) has remained relatively flat, and has actually increased by approximately 3% over the same time interval. After excluding the 2010 BAC performance, which currently makes up 7% of the financial ETF, XLF would have appreciated by around 5%.

Fundamental ValuationBank of America currently carries $131 billion of cash and cash equivalence on its balance sheet, which amounts to about $13.14 per share. Furthermore, with $2.339 trillion dollars in total assets and $2.109 trillion in total liabilities, the book value of BAC shares sits at slightly over $23. Based on these metrics and its current trading price of around $11.70, Bank of America is trading at cheap multiples.

In its latest financial quarter, BAC generated total revenues, net of interest expenses of $26.7 billion, which was slightly greater than its performance for the equivalent 2009 period. However, compared to 2009 when the bank suffered a loss of 26 cents per diluted share, third quarter earnings performance was significantly worse at a loss of 77 cents a share. Much of this loss arose from a $10.4 billion goodwill impairment. Without the impairment, earnings would have actually been 27 cents per share.

Balance Sheet ImprovementsDespite a major decrease in share price, Bank of America has been showing significant balance sheet improvements in crucial areas. The banks total asset base increased by $4.1 billion throughout the year while its long term debt was reduced by $44 billion. Tier 1 common equity increased by 12.7% and the tier 1 common equity ratio improved by 137 basis points. With improving credit conditions, the provision of credit losses was also reduced by nearly 50% compared to the same time last year. Account attrition also improved by 27% compared to 2009 third quarter results.

RisksA primary concern with the Bank of America balance sheet is the $478.9 billion dollar of long term debt, which creates an excessive net debt position. However, this type of scenario is common for major financial institutions. JP Morgan (NYSE:JPM), for example, holds $24 billion of cash, but carries long term debt of over $255 billion. Nonetheless, BAC remains relatively more levered as its long term debt to total assets ratio stands at 0.205, while the corresponding metric for JPM is 0.119. The risks of excess leverage have been slowly emerging, as Bank of America has taken on more long term debt as a percentage of total assets every year since 2005.

Bottom LineAmong the major US banks, Bank of America has suffered the most extensive losses to its share price, performing far worse than JP Morgan, Goldman Sachs (NYSE:GS), Wells Fargo (NYSE:WFC) and Citigroup (NYSE:C). With a per share cash position and book value that exceed the current trading price, BAC may be undervalued even after factoring in the added leverage risks. As indicated previously, commendable efforts have been made to reduce the debt burden of the bank. (Find out what most investors are doing wrong, and how you can do it right. See 10 Timeless Rules For Investors.)